FLASH ECONOMICS

ECONOMIC RESEARCH

December 29, 2015 - No. 1016

Monetary policies and rising debt ratios:

An incentive for permanently expansive
monetary policies

In the past, the stock of debt (public and private) was small. Monetary
policies had an effect on the economy through changes in the cost of
capital, which had an effect on corporate investment and housing
investment.
Today, debt ratios are extremely high. Monetary policies act primarily
through their effect on the market value of debt and on the level of interest
payments on debt. This change makes expansionary monetary policies
much more effective (when long-term interest rates fall there is an effect
through both the cost of capital as well as through the increased wealth of
lenders and the improvement in borrowers solvency and incomes) but also
makes them much more difficult to exit (capital losses for lenders, loss of
income and solvency for borrowers).
The increase in debt ratios therefore creates an incentive to conduct highly
expansionary monetary policies (they are effective) and an incentive to not
exit these policies, given the associated risks, resulting in a bias towards
permanent monetary expansion.

Author:
Patrick Artus

FLASH

Debt ratios have

surged

We will look at the situations of the United States, the United Kingdom, the
euro zone and Japan.
In all these countries, debt ratios have increased considerably, both for private
and public debt (Charts 1A and B and 2).

Chart 1A
Household + corporate debt (as % of nominal GDP)
United States
Euro zone

Chart 1B
Public debt (as % of nominal GDP)

United Kingdom

United States

United Kingdom

Japan

Euro zone

Japan

250

250

250

225

225

200

200

175

175

150

150

125

125

100

100

75

75

200

200

150

150

100

100

50

50

Sources: Datastream, Central Banks, Natixis

50

50
70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

250

Sources: Datastream, Natixis

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

Chart 2
Total debt* (as % of nominal GDP)

450
400

United States

United Kingdom

Euro zone

Japan

(*) households + companies + general government

450
400

350

350

300

300

250

250

200

200

150

150
Sources: Datastream, Natixis

100

100
70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

We will show that this increase in debt ratios encourages central banks to
maintain an expansionary bias in their monetary policies.
Effects of debt ratios
on monetary policies

(1) In the past (1970s-80s and even 1990s), debt ratios were low; monetary
policy acted through changes in the cost of capital.
In this old regime, when short-term and therefore long-term interest rates fell,
above all there was an upturn in corporate and housing investment.
Charts 3A, B, C and D show that this happened in:

Flash 2015 1016 - 2

The United States: 1976-77; 1983-84; 1992-94; 1998-99;

The United Kingdom: 1978-80; 1983-84; 1988-89; 1993-94; 1997-98;

The euro zone: 1976; 1980; 1986-89; 1993-94; 1998-99;

Japan: 1979; 1987-88; 1994-96.

FLASH

Chart 3B
United Kingdom: Interest rate and investment

Chart 3A
United States: Interest rate and investment

18

10-year Treasury interest rate (as %, LH scale)

Productive investment (in volume terms, Y/Y as %, RH scale)
Housing investment (in volume terms, Y/Y as %, RH scale)

18

12

40

15

30

12

10
0

20
10

0
-10

-20

-10

-20
Sources: Datastream, BEA, Natixis

-30

3
0

Chart 3C
Euro zone: Interest rate and investment
10-year govt. interest rate (as %, Germany)
Productive investment (in volume terms, Y/Y as %)
Housing investment (in volume terms, Y/Y as %, RH scale)

-40

Chart 3D
Japan: Interest rate and investment

16

12

12

-4

-4

-8

-8

-12

-12
Sources: Datastream, Eurostat, Natixis

-30
Sources: Datastream, ONS, Natixis

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

-16

30

20

16

40

50

15

60

10-year Gilt interest rate (as %, LH scale)

Productive investment (in volume terms, Y/Y as %, RH scale)
Housing investment (in volume terms, Y/Y as %, RH scale)

-16

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

10-year govt. interest rate (as %, LH scale)

Productive investment (in volume terms, Y/Y as %, RH scale)
Housing investment (in volume terms, Y/Y as %, RH scale)

12

40
32

10

24
16

8
0

-8
4

-16
-24

-32
Sources: Datastream, CAO, Natixis

-40

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

(2) Today, debt ratios are very high. A fall (for example) in interest rates (shortterm and long-term) now has several effects:
-

Fall in the cost of capital, like before;

Increase in the market value of bond portfolios (Charts 4A, B and C) due to
the fall in long-term interest rates (Chart 5);
Chart 4B
Outstanding bonds held by banks
(as % of nominal GDP)

Chart 4A
Outstanding bonds held by institutional investors
(as % of nominal GDP)
70
60

United States
United Kingdom
Euro zone
Japan

70
250

United States
Euro zone

United Kingdom
Japan

250

60
200

200

150

150

30

100

100

20

50

50

10

50

50

40

40

30
20
Sources: Datastream, Fed, BoJ, ONS, ECB, Natixis

10
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Sources: Datastream, Fed, BoJ, ONS, ECB, Natixis

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Flash 2015 1016 - 3

FLASH

Chart 4C
Outstanding bonds held by households
(as % of nominal GDP)

Chart 5
Interest rate on 10-year government bonds (as %)

United States

United Kingdom

Euro zone

Japan

United States

United Kingdom

Germany

Japan

40

35

35

30

30

25

25

20

20

15

15

10

10

40

Sources: Datastream, Fed, BoJ, ONS, ECB, Natixis

Sources: Datastream, Natixis

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

These capital gains in bond portfolios boost demand through wealth effects.
-

Fall in interest paid by borrowers (Charts 6A, B and C).

Chart 6A
Interest paid by companies (as % of nominal GDP)

Chart 6B
Interest paid by households (as % of nominal GDP)

United States

United Kingdom

United Statess

United Kingdom

Euro zone

Japan

Euro zone

Japan

1
Sources: Datastream, BEA, Eurostat, ONS, CAO, Natixis

Sources: Datastream, BEA, Eurostat, ONS, CAO, Natixis

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Chart 6C
Interest paid on the public debt
(as % of nominal GDP)
United States

United Kingdom

Euro zone

Japan

Sources: Datastream, OECD, AMECO, Natixis

1
02

03

04

05

06

07

08

09

10

11

12

13

14

15

This fall in the interest paid by borrowers boosts their incomes and improves
their solvency.

Flash 2015 1016 - 4

FLASH

So what consequences does the increase in debt ratios hold for monetary
policies?

Conclusion:
Monetary policies
expansionary bias is
understandable

Central banks are encouraged to conduct expansionary monetary policies

when debt ratios are high, since they are effective at stimulating activity (fall
in the cost of capital, increase in lenders wealth, increase in borrowers
incomes and solvency);

Central banks are encouraged to not exit their expansionary monetary

policies, since this exit would have drastic negative effects: capital losses
on bond portfolios, significant loss of income and decline in solvency for
borrowers.

Monetary policies in OECD countries clearly display an increasing

expansionary bias: low interest rates relative to growth (Charts 7A, B, C and
D), growth in the monetary base (Chart 8).

Chart 7B
United Kingdom: Nominal GDP, monetary policy
rate and interest rate on 10-year Gilts

Chart 7A
United States: Nominal GDP, monetary policy rate
and interest rate on 10-year Treasuries
Nominal GDP (Y/Y as %)
Fed Funds rate (as %)
10-year rate Treasury (as %)

10

Nominal GDP (Y/Y as %)

BoE base rate (as %)
10-year Gilt interest rate (as %)

10

10

10

-2

-2

-2

-4

-2
Sources: Datastream, BEA, Natixis

-4

-4
02

04

06

08

10

12

14

16

-4
Sources: Datastream, ONS, BoE, Natixis

-6

Chart 7D
Japan: Nominal GDP, monetary policy rate and
interest rate on 10-year government bonds

Chart 7C
Euro zone: Nominal GDP, monetary policy rate and
interest rate on 10-year government bonds

Nominal GDP (Y/Y as %)

Euro repo rate (as %)
German 10-year govt. interest rate (as %)

Nominal GDP (Y/Y as %)

BoJ base rate (as %)
10-year govt. interest rate (as %)

8
4

-2

-2

-4

-4

-6

-6

-2

-2

-4

-4

-8

-6

-10

Sources: Datastream, ECB, Natixis

-6
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

-6

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

-8

Sources: Datastream,
BoJ, Natixis

-10
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Flash 2015 1016 - 5

FLASH

Chart 8
Monetary base (as % of nominal GDP)

80

United States

United Kingdom

Euro zone

Japan

70

70

60
50

80

60
Sources: Datastream, Fed,
BoE, ECB, BoJ, Natixis

50

40

40

30

30

20

20

10

10

0
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

We believe the above explains this expansionary bias.

The high level of debt ratios:

Flash 2015 1016 - 6

Prompts central banks to conduct expansionary monetary policies, which are

more effective thanks to wealth effects and the effects on the incomes and
solvency of borrowers;

But also prompt central banks to not exit their expansionary monetary policies,
as exiting them can trigger a financial crisis (capital losses on bond portfolios,
decline in borrower solvency).

FLASH

Flash 2015 1016 - 7